May 5 (Bloomberg) -- China's economy is at risk of overheating and policy makers may raise interest rates and do more to soak up the cash flooding the financial system, officials said.

``We will combat demand and prevent rapid economic growth from turning into overheating,'' Vice Finance Minister Li Yong told delegates at the Asian Development Bank's annual meeting in Madrid today.

Consumer prices rose 8.3 percent in March, close to an 11- year high, as food costs soared and the trade surplus pumped $13 billion into the financial system. China is trying to cool growth without triggering a slump in the world's fastest-growing major economy as export demand wanes.

``We always say there is a possibility to use interest rates'' to restrain inflation, central bank Governor Zhou Xiaochuan told reporters in Basel, Switzerland, adding that policy makers have a range of options.

China's economy, the world's fourth-largest, expanded 10.6 percent in the first quarter, down from 11.2 percent in the previous three months. Consumer prices climbed 8.7 percent in February, the fastest pace since 1996.

``Growth has started to slow, why take the risk of taking additional cooling measures and risk stalling the economy?'' asked Leslie Phang, Singapore-based head of private clients at Schroders Plc, which manages $275 billion.

Overseas investors attracted by the yuan's gains and climbing interest rates have channeled money into China, adding to the inflows from trade and foreign direct investment. The benchmark one-year lending rate is at a nine-year high of 7.47 percent after six increases last year.

`New Situation'

Rate cuts by the U.S. Federal Reserve have created a ``new situation'' for China, attracting short-term investors, Zhou said, adding that the Chinese government is monitoring the inflows of so-called hot money.

``China is a very large economy -- usually a small amount of abnormal capital inflow doesn't have a serious impact on monetary policy,'' the central banker said. Zhou has been in Basel for a Bank of International Settlements meeting.

China will do more to ``sterilize'' inflows, Li said, using a term that describes measures such as sales of government bills to take currency out of circulation. He said he was also referring to bank reserve requirements -- already raised three times this year to require lenders to set aside a record 16 percent of deposits.

`Strengthen Our Efforts'

``We will strengthen our efforts in sterilizing excess liquidity by using a combination of tools such as open-market operations and required-reserves ratios,'' Li said. The government will maintain a tight monetary policy, he added.

Commodity prices are adding to inflationary pressures.

While the nation will take ``lots of action,'' including reducing the money supply, to stem inflation, it can do little about global price increases, Li said.

China won't increase capital controls to curtail money inflows, said Li, who also reiterated the policy of allowing the yuan's flexibility to increase.

Economic growth this year is likely to exceed the government's 8 percent target, Li said.

``The priority is to maintain sound and fast economic growth,'' the official said. ``We put sound first, not fast first.''

To contact the reporters on this story: Shamim Adam in Madrid sadam2@bloomberg.net

Last Updated: May 5, 2008 05:32 EDT